Documents considered by the Committee on 11 January 2017 Contents

6Financial services regulatory framework: resolution and recovery, capital requirements and central counterparties

Committee’s assessment

Politically important

Committee’s decision

(a), (b), (d), (e) and (g) not cleared from scrutiny, further information requested; (c) and (f) cleared from scrutiny

Document details

(a) Proposed Directive concerning bank resolution and recovery; (b) Proposed Directive about the ranking of unsecured debt instruments in insolvency hierarchy; (c) Proposed Regulation concerning aspects of the Single Resolution Mechanism; (d) Proposed Directive concerning aspects of capital requirements; (e) Proposed Regulation concerning aspects of capital requirements; (f) Commission Communication concerning the EU regulatory framework for financial services; (g) Proposed Regulation concerning central counterparties

Legal base

(a),(b), (d), (e) and (g) Article 114 TFEU, ordinary legislative procedure, QMV; (c) Article 53(1), ordinary legislative procedure, QMV; (f) —


HM Treasury

Document Number

(a) (38300), 14777/16 + ADDs 1–2, COM(16) 852; (b) (38301), 14778/16 + ADDs 1–2, COM(16) 853; (c) (38302), 14779/16 + ADDs 1–2, COM(16) 851; (d) (38303), 14776/16 + ADDs 1–2 COM(16) 854; (e) (38304), 14775/16 + ADDs 1–3, COM(16) 850; (f) (38311) 14903/16 + ADDs 1–2, COM(16) 855 (g) (38332), 14835/16 + ADDs 1–3, COM(16) 856

Summary and Committee’s conclusions

6.1Following the very severe financial crisis some years ago the EU adopted a considerable amount of regulatory legislation aimed at restoring the stability of the financial services sector and preventing future problems. Much of the legislation was based on internationally agreed standards. Although the legislation has concerned all Member States, implementation of significant parts of it has been centralised for eurozone Member States through development of the Banking Union.

6.2Practical experience of the legislation and further development of standards in international fora have led to the need for amendment of important elements of the EU legislation. Most recently the Commission has published a Communication analysing the results of a public inquiry it conducted in 2015 and 2016 into the EU regulatory framework for financial services. The Communication also sets out the intentions for legislative and non-legislative proposals in response to the outcome of the inquiry. At the same time the Commission presented six legislative proposals, for amendment to present legislation concerning capital requirements for credit institutions and investment firms, bank recovery and resolution, central counterparties and the Banking Union’s Single Resolution Mechanism.

6.3These complex and technical proposals affect many important aspects of EU financial regulation. They range from measures to ensure the regulation of non-bank entities is more appropriate and proportionate to measures to implement recent significant developments in international standards. There are significant interrelationships between them, which are not apparent on first reading of the Government’s Explanatory Memoranda.

6.4The Government is generally supportive of the Commission’s proposals. But its comments to us about the very detailed provisions show its laudable wish to ensure that EU legislation is entirely consistent with agreed international standards, is flexible and proportionate and does not give the European Securities and Markets Authority and the Commission powers to set technical detail which ought to be in the primary legislation.

6.5We clear the Commission Communication and the proposed Single Resolution Mechanism Regulation from scrutiny, since the former covers matters which are now or will be subject to detailed scrutiny and the latter has no direct relevance for the UK.

6.6The other five legislative proposals remain under scrutiny. Clearly the Government will need to negotiate carefully much of the many details it has drawn to our attention to ensure everything in them when adopted meets its concerns. So we wish to be kept informed regularly about negotiating developments on each proposal.

6.7More generally we wish to be told soon about the likely implementation dates of the proposals in the context of the probable Brexit date. We should also like to have the Government’s assessment of the consequences for the UK of these proposals. In particular would its aim post-Brexit to be closer to the relevant international standards or the EU ones, if there were any divergence between the two.

6.8Clearly negotiation of each of these proposals may proceed at a different pace to the others. So separate report backs by the Government might be appropriate and if so would be acceptable.

Full details of the documents

(a) Proposed Directive amending Directive 2014/59/EU on loss-absorbing and recapitalisation capacity of credit institutions and investment firms and amending Directive 98/26/EC, Directive 2002/47/EC, Directive 2012/30/EU, Directive 2011/35/EU, Directive 2005/56/EC, Directive 2004/25/EC and Directive 2007/36/EC: (38300), 14777/16 + ADDs 1–2, COM(16) 852; (b) Proposed Directive on amending Directive 2014/59/EU of the European Parliament and of the Council as regards the ranking of unsecured debt instruments in insolvency hierarchy: (38301), 14778/16 + ADDs 1–2, COM(16) 853; (c) Proposed Regulation amending Regulation (EU) No 806/2014 as regards loss-absorbing and recapitalisation capacity for credit institutions and investment firms: (38302), 14779/16 + ADDs 1–2, COM(16) 851 (d) Proposed Directive amending Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers and capital conservation measures: (38303), 14776/16 + ADDs 1–2 COM(16) 854; (e) Proposed Regulation amending Regulation (EU) No 575/2013 as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements and amending Regulation (EU) No 648/2012: (38304), 14775/16 + ADDs 1–3, COM(16) 850; (f) Commission Communication: Call for Evidence — EU regulatory framework for financial services: (38311) 14903/16 + ADDs 1–2, COM(16) 855; (g) Proposed Regulation on a framework for the recovery and resolution of central counterparties and amending Regulations (EU) No 1095/2010, (EU) No 648/2012, and (EU) 2015/2365: (38332), 14835/16 + ADDs 1–3, COM(16) 856.


6.9The EU “single rulebook” legislation collectively governs the financial services sector across the EU. The provisions of the single rulebook are set out in three main legislative acts:

6.10Central counterparties (CCPs) play an essential role in financial markets and improve overall stability and resilience of financial markets through the management of counterparty, liquidity and market risk. CCPs provide their services directly to clearing members, which are typically banks. In addition, many other market participants such as pension funds access CCPs indirectly through clearing members. Specifically, a CCP intervenes between financial market participants to act as a buyer to every seller and a seller to every buyer of a trade. Performance by the CCP of its side of the transaction is guaranteed and counterparty credit risk for the original parties is reduced. CCPs also facilitate multilateral netting and thereby help to reduce exposures between counterparties.

6.11The Pittsburgh G20 meeting in 2009 agreed to reforms to derivatives markets to reduce systemic risk and provide greater market transparency.9 The reforms included a requirement for all standardised over-the-counter (OTC) derivative contracts to be cleared through CCPs by the end of 2012. This is implemented in the EU by means of the European Market Information Regulation (EMIR).10 The G20 has also called for internationally-consistent recovery arrangements and resolution plans for systemically important financial firms, including CCPs.11

6.12The EU’s Banking Union is intended to transfer responsibility for banking policy from the national to the EU level. The motivation is the fragility of eurozone banks and the link between credit conditions for some of these banks and the sovereign credit of their respective home countries. The Banking Union has two main components. The first is the Single Supervisory Mechanism which gives the European Central Bank a supervisory role monitoring implementation of the single rulebook and the financial stability of banks based in participating states. Participation is automatic for eurozone Member States and voluntary for others. So far no non-eurozone Member State has opted into the system. The second pillar is the Single Resolution Mechanism (SRM), which is to centrally implement the BRRD in participating Member States, and would establish a Single Resolution Fund to finance their restructuring. The SRM entered into force on 1 January 2016 and all eurozone Member States participate in it.

6.13In November 2015, the international Financial Stability Board (FSB)12 agreed a total loss absorbing capacity (TLAC) standard for Global Systemically Important Banks (G-SIBs), set at a level which should ensure that if a G-SIB fails it has sufficient loss-absorbing and recapitalisation capacity available in resolution to implement an orderly resolution that minimises impacts on financial stability, ensures the continuity of critical functions, and avoids exposing public funds to loss.

6.14Similarly, in the EU, the BRRD requires resolution authorities to set an individual loss absorbing capacity requirement for each bank within its jurisdiction. This is known as the ‘minimum requirements for own funds and eligible liabilities’ (MREL). Taken in conjunction with the resolution tools, MREL/TLAC implementation should mean that in future when a firm fails, the costs will be borne by the creditors of a failed firm, rather than by the taxpayer.

6.15On 30 September 2015, the Commission launched a public consultation “Call for Evidence: EU regulatory framework for financial services”, which was part of the Commission’s 2016 work programme as a REFIT (Regulatory Fitness and Performance Programme) item. The purpose was to consult all interested stakeholders on the benefits, unintended effects, consistency, gaps in and coherence of the EU regulatory framework for financial services. It also aimed to gauge the impact of the regulatory framework on the ability of the economy to finance itself and grow. The consultation closed on 31 January 2016.

6.16In November 2015 the Commission, in its Communication “Towards the completion of the Banking Union”, committed to proposing legislation based on international agreements, in order to address identified weaknesses in the existing prudential framework.13

The documents

6.17In November 2016 the Commission published a Communication, document (f), which analysis the results of its consultation on the EU regulatory framework for financial services and summarises its present and intended follow-up action. It refers particularly to six legislative proposals dealt with in this chapter: documents (a)–(e) and (g). Amongst other matters the Commission also refers to a Communication and two Reports, concerning the Capital Markets Union, assignment or subrogation of claims against third parties and OTC derivatives, CCPs and trade repositaries, which we are clearing from scrutiny as they do not raise questions of sufficient legal or political importance to warrant a substantive report to the House.14

6.18In November 2016 the Commission published five legislative proposals, concerning the CRD IV, the BRRD and the SRM, with which it seeks further measures to reduce risk in EU’s banking system, in order to strengthen both the resilience of the banking sector as well as to advance completion of the Banking Union. It says that its intention is completion of the post-financial crisis regulatory reforms and implementation of internationally agreed standards that have only recently been finalised by international organisations, such as the Basel Committee on Banking Supervision (BCBS)15 and the FSB.

6.19With a proposed Directive, document (d), the Commission suggests amendments to the CRD, as follows:

6.20With a proposed Regulation, document (e), the Commission suggests amendments to the CRR, as follows:

6.21In a first report of its review of investment firms the European Banking Authority found that the bank-like rules under the CRR were not fit for purpose for the majority of investment firms, with the exception of the more systemic ones that pose risks similar to those faced by credit institutions. The Authority’s review is now in its second phase, with additional analytical work in order to determine a more appropriate and proportionate capital treatment for investment firms, and it is expected to deliver its final input to the Commission in June 2017. The Commission intends to present legislative proposals setting-up a specific prudential framework for non-systemic investment firms by the end of 2017. In the meantime it is considered appropriate to allow investment firms that are not systemic to apply the present version of the CRR. However, systemic investment firms will be subject to the amended version of the CRR. This will ensure that systemic firms are treated appropriately while reducing the regulatory burden for non-systemic firms.

6.22With a proposed Directive, document (a), the Commission suggests amendments to the BRRD, as follows:

6.23With a proposed Regulation, document (c), the Commission suggests amendments to the SRM in order to implement the TLAC standard for firms under the SRM.

6.24With a proposed Directive, document (b), the Commission suggests further amendment to the BRRD, to introduce a harmonised approach to statutory subordination by requiring Member States to create a new class of ‘non-preferred’ senior debt. This would require Member States to amend their insolvency creditor hierarchy specific to bank and investment firm insolvencies. The proposed ranking of unsecured debt instruments in the insolvency hierarchy sits alongside the Commission’s proposals to introduce the TLAC standard into EU law and to update the framework for setting MREL.

6.25The BRRD requires, and the UK’s Banking Act provides, safeguards for creditors and shareholders of an institution in the event of resolution, including that they are not left worse off than if the institution had entered insolvency instead—the no creditor worse off (NCWO) safeguard. Affected creditors must be compensated if the NCWO safeguard is breached.

6.26The ability to subordinate MREL resources to senior operating liabilities is important because it aligns the order of loss absorption in resolution and insolvency. Subordination of MREL resources means these resources would rank below liabilities related to the day-to-day operations and critical economic functions of an institution. This ensures that MREL resources can fulfil their purpose of providing the capacity to absorb losses and recapitalise, without the resolution authority needing to treat similarly ranking liabilities differently. Subordination therefore reduces the risk of breaches of the NCWO safeguard in the event of a bail-in. This is important in limiting public funds risks due to the obligation to pay compensation. The subordination of MREL resources to senior operating liabilities can be achieved by different channels: structural, contractual, or statutory subordination.

6.27With a proposed Regulation, document (g), the Commission suggests a framework for the recovery and resolution of CCPs (as defined in EMIR). It is aligned to the G20 agreements and aims to be consistent with international standards agreed in the FSB’s Key Attributes of Effective Resolution Regimes for Financial Institutions.18

6.28The Commission’s proposal:

6.29The proposed Regulation covers a number of key areas including:

6.30While recovery measures aim to ensure the CCP is itself capable of restoring its position with a view to long-term viability, resolution measures allow an authority to intervene directly to resolve a CCP if recovery measures fail or threaten to negatively impact financial stability. Together, recovery and resolution planning enables the CCP and the resolution authority to gain a better understanding of the CCP’s critical functions, legal status, risk profile and interconnectedness. Shareholders, clearing members and clients would also be better informed of how financial distress in a CCP may affect their rights and obligations in relation to the CCP as part of its recovery plan.

6.31The Commission proposes:

6.32The Commission proposal sets out early intervention measures which a supervisory authority may adopt during, or prior to, the recovery phase of the CCP with a view to restoring the financial resilience of the financially distressed CCP or other steps to protect financial stability. These measures are in addition to the prudential requirements established by EMIR. As part of the early intervention measures supervisors would be enabled to carry out enhanced monitoring and have powers to require CCPs to replenish their financial resources if they had used their capital to absorb losses during a recovery. The supervisory authority would be enabled to require the total or partial removal of the senior management or board where there is a significant deterioration in the financial situation of the CCP or it infringes its legal requirements or operational rules.

6.33Should a CCP meet the framework’s conditions for resolution, the proposed Regulation provides that the resolution authority should place the CCP in resolution and apply a resolution tool or exercise a resolution power. The use of these resolution tools and powers by the resolution authority is to be guided by the proposal’s resolution objectives and general principles. The proposed Regulation provides the resolution authority with a set of resolution tools. First are position allocation tools and loss allocation tools. Position allocation tools enable the resolution authority to restore a CCP to a matched book by for example terminating some or all contracts between the CCP in resolution and other clearing members. Loss allocation tools enable the resolution authority allocate any remaining losses by requiring non-defaulting clearing members to make a cash contribution to the CCP and by haircutting the amounts payable by the CCP on any positions in profit (known as variation margin gain haircutting, or VMGH). Second are write-down and conversion tools, which allow resolution authorities to write-down equity in resolution and convert debt instruments and unsecured debts into instruments of ownership (such as shares). The tools would allow resolution authorities to absorb losses, to recapitalise the CCP or to support the use of the sale of business tool. Next is the sale of business tool, which allows resolution authorities to transfer the CCP under resolution, or shares in it, (or assets, rights or obligations belonging to the CCP) to a purchaser without obtaining the consent of the shareholders or any third party (other than the purchaser) or complying with any procedural requirements under company or securities law. Finally, the bridge CCP tool allows resolution authorities to transfer all (or specified assets, rights or liabilities) of a CCP under resolution to a legal entity controlled by the resolution authority and owned by a public authority without obtaining the consent of the shareholders or any third party.

6.34The proposal does not mandate the specific tools and powers that should be used by an authority in resolution. This will depend on the resolution plan agreed by the resolution college. However in the case of default losses, position allocation and loss allocation tools will need to be used to restore the CCP to a matched book and to absorb any default-related losses—this cannot be achieved by the sale of business or bridge CCP tools alone.

6.35Resolution authorities are required to establish and chair resolution colleges. These colleges are to provide a framework for resolution authorities to perform their tasks in relation to resolution planning, assessing the resolvability of CCPs and removing impediments to resolution. For example, resolution colleges are required to approve or propose amendments to the resolution plan proposed by the CCP’s resolution authority. Importantly, the home resolution authority would be able to make decisions without having to consult the resolution college at the point of resolution.

6.36Membership of resolution colleges set out in the proposed Regulation is broad and includes home resolution and competent authorities, including those authorities of the largest clearing members of a CCP, finance ministries and central banks that clear key currencies. It is specified that ESMA should act as a binding mediator in a number of circumstances. Specifically, the resolution college will need to form a joint opinion on a resolution and on any measures identified to address impediments to resolvability of a CCP. If any college member does not agree with an issue, it can escalate the issue to ESMA for binding mediation. In addition, the proposal also applies the binding mediation process to decisions over recovery plans which are to be taken by competent authorities in the colleges.

6.37The proposal provides for an ESMA Resolution Committee, composed of Member State resolution authorities, to be established for the purpose of preparing ESMA decisions in relation to the proposed Regulation. Resolution Committees would promote the development and coordination of resolution plans and develop methods for the resolution of failing CCPs.

6.38Many CCPs provide clearing services to members established in other jurisdictions and the failure of such a CCP is likely to have effects across multiple jurisdictions. The proposed Regulation has provisions relating to third countries which enable the Commission to submit proposals to the Council for the negotiation of agreements with third country authorities regarding the cooperation between resolution authorities in connection with recovery and resolution planning. Pending a cooperation agreement, the proposal provides for the recognition and enforcement of third country resolution proceedings and for cooperation agreements to be established bilaterally between Member State resolution authorities and third country resolution authorities.

6.39The proposed Regulation delegates the development of certain aspects of the technical detail to ESMA, requiring it to submit five draft technical standards and two guidelines to the Commission within 12 months of the proposal coming into force (save for guidelines on cooperation with third country authorities , which ESMA would have 18 months to submit). These technical standards would be drawn up in accordance with the ESMA legislation, which requires the Authority to consider the costs and benefits and to consult publicly, and requires the Commission to consult the European Council and Parliament.

6.40The proposed Regulation includes consequential changes to EMIR, the ESMA Regulation and the Securities Financing Transactions Regulation. Additionally, the proposed Directive to amend the BRRD, document (a), includes provisions to apply amendments to the Company Law Directives made by BRRD in respect of credit institutions, to CCPs. It also takes CCPs with banking licences out of the BRRD, bringing them exclusively under the arrangements set out in this proposed Regulation, and applies the sanctioning powers of authorities in the BRRD also to CCPs.

6.41The five legislative proposals concerning CRD IV, the BRRD and the SRM, documents (a)-(e), are each accompanied by the same Commission impact assessment and executive summary of the assessment. The CCP proposal has a separate Commission impact assessment and executive summary.

The Government’s view

6.42The Economic Secretary to the Treasury (Simon Kirby) has provided us with four Explanatory Memoranda in relation to these documents.

6.43In his Explanatory Memorandum of 14 December 2016 about the Commission Communication, document (f), the Minister says merely that:

6.44In his Explanatory Memorandum of 20 December 2016 about one of the legislative proposals on the BRRD and those on CRD IV and the SRM, documents (a), (c)–(e), the Minister first repeats the Government’s very familiar ritualistic statement that:

“On 23rd June the EU referendum took place and the people of the United Kingdom voted to leave the European Union. The UK remains a full member of the EU until withdrawal. Full rights and responsibilities continue to apply and UK will continue to play a constructive role and fulfil our responsibilities in the meantime. Now that the proposal has been adopted by the Commission it will be negotiated in Council and European Parliament in the usual way, and the UK will defend its interests.”

6.45On the CRD IV proposals, documents (d) and (e), the Minister says that:

6.46The Minister continues that the Government strongly supports international harmonisation and the implementation of the internationally agreed BCBS standards and that, as negotiations progress, it will push for EU standards to be updated in line with developments internationally. He comments that international harmonisation provides regulatory certainty and supports financial stability, reducing costs to the wider economy and contributing to collective growth and competitiveness. He says that in that context the Government supports measures implementing international standards on:

6.47Turning to some of the detail of the CRD IV proposals the Minister says that:

6.48On the main BRRD proposal, document (a), the Minister says:

6.49In relation to amending the SRM, document (c), the Minister merely notes that the SRM does not apply to the UK.

6.50In his Explanatory Memorandum of 14 December 2016 on the second BRRD proposal, document (b), the Minister says that:

6.51In his Explanatory Memorandum of 14 December 2016 about the CCP proposal, document (g), the Minister discusses first subsidiarity, saying that:

6.52The Minister introduces his comments on the policy implications of the CCP proposal by repeating the Government’s ritual Brexit statement. He then says that:

6.53Turning to the financial implications of the CCP proposal the Minister says that:

Previous Committee Reports


13 See (37333), 14650/15: Fifteenth Report, HC 342-xiv (2015–16), chapter 16 (16 December 2015).

14 (38086) 12302/16, (38113) 12773/16, (38314) 14828/16: see chapter 16 of this Report.

16 Tier 1 capital is the core measure of a bank’s financial strength—it is composed of core capital, primarily common stock and disclosed reserves (or retained earnings), but possibly also non-redeemable non-cumulative preferred stock.

19 The Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions.

13 January 2017